Just because the Bank of England says base rates are at x% that does not mean that banks can get hold of money at this level. The system is still frozen even though it is no longer headline news. Bank and Building Societies etc are having to pay 1%+ over the official interest rate to borrow funds. One of the problems is that the Libor rate is set by taking the average given by a series of Bank lending rates over differing periods. However the set of banks used for this are all the really big boys (many international) who have fewer problems in raising actual cash than the smaller operators.
Unfortunately if a bank lends you money it, not unreasonably, wants to make a profit on the deal. If they can only get hold of funds at 6% then they are hardly going to lend it to you at less.
This is also the problem with blaming Northern Rock for their business model. Most of their mortgages would have been of the ‘Variable’ type, at risk of short term changes in the Bank of England base rate. Before last summer (when the credit crunch was an unknown phenomenon) you could hardly blame the bank for following a short term borrowing regime when their risk on the lending side was also an exposure to short term rates. If they had borrowed 3 year money at 6.25% and then rates fell sharply they would have been looking at hefty losses as their clients would have expected to be paying lower mortgage rates in line with other lenders. When the credit crunch arrived even an ‘off balance sheet’ hedge would not have been very helpful as this is not actual money. It is just a promise to pay a ‘cash for difference’ amount on the maturity of the deal.
Northern Rock was undone because it was a Mortgage Bank concentrating in one sector. Other banks had other areas to fall back on when times got tough.
The problem for investors is not the value as expressed today but the value in a few years time. With shell-shocked balance sheets, massive capital injections (at considerable cost) and virtually no chance of big takeover or merger stories (except in extremis) bank sector analysts are worrying about future growth potential. Share prices reflect not so much the value of a company today but the probability of growth tomorrow. A company showing 20% long term growth history will trade on a much better multiple than one showing 5% or 10%. So how do you value a sector that is in danger of giving negative numbers for the foreseeable future and may very well have further shocks from, as yet, unforeseen quarters?
As Simon Denom of Capital Spreads recently commented, “with so much these days this whole question will revolve around your expectations for the state of the global economy. If, like many, you believe in world wide economic weakness then, even at current prices, the banks may very well be poor value. However if you are more optimistic and believe that the Non Western portion of the global environment will pull us out of the fire then a small dabble may well pay off in the long term”.
Note - Spread Betting carries a high level of risk to your capital and you can lose more than your initial investment, it may not be suitable for all investors. Ensure you only speculate with money that you can afford to lose and that you fully understand the risks involved and seek independent financial advice where necessary.
'Spread Trading the Banking Sector', Feature by D. Jones, last update: 19-Sep-08
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